What is liquidation in crypto?

Liquidation is the forced settlement of debt or a trading position after a risk limit is breached. In DeFi lending, some or all debt may be repaid in exchange for collateral. In derivatives trading, insufficient margin may trigger closure under the venue’s rules. The thresholds and costs are not interchangeable.

For collateralized protocols such as Aave, health factor helps identify liquidation conditions. A collateral price decline is not the only trigger: appreciation of the borrowed asset or accumulated interest can increase the liability.

Example

Suppose a liquidator repays $500 of debt in a hypothetical DeFi position. Assume a 5% liquidation bonus is added when calculating collateral received and ignore other deductions. The collateral removed would be $525. The borrower’s debt falls by $500 while collateral falls by $525. That illustrative bonus is not a universal Aave rate; network costs and the remaining position require separate calculation.

Liquidation does not always close the entire loan. Verify remaining debt and collateral from the transaction record. A price alert or a submitted transaction cannot guarantee prevention; an intervention must complete successfully in time.

The health factor entry gives a short calculation. The collateral-monitoring guide explains how to track debt and collateral together.